Working Paper: CEPR ID: DP10370
Authors: Marcel Fratzscher; Malte Rieth
Abstract: The paper analyses the empirical relationship between bank risk and sovereign credit risk in the euro area. Using structural VAR with daily financial markets data for 2003-13, the analysis confirms two-way causality between shocks to sovereign risk and bank risk, with the former being overall more important in explaining bank risk, than vice versa. The paper focuses specifically on the impact of non-standard monetary policy measures by the European Central Bank and on the effects of bank bailout policies by national governments. Testing specific hypotheses formulated in the literature, we find that bank bailout policies have reduced solvency risk in the banking sector, but partly at the expense of raising the credit risk of sovereigns. By contrast, monetary policy was in most, but not all cases effective in lowering credit risk among both sovereigns and banks. Finally, we find spillover effects in particular from sovereigns in the euro area periphery to the core countries.
Keywords: bank bailout; banks; credit risk; heteroscedasticity; monetary policy; sovereigns; spillovers
JEL Codes: E52; E60; G10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Sovereign CDS spreads increase by 100 basis points (F65) | Bank spreads increase by 38 basis points (G21) |
| Bank risk deteriorates by 100 basis points (G21) | Sovereign risk worsens by 28 basis points (F34) |
| Bank bailout policies (G28) | Reduced bank solvency risk (G21) |
| Bank bailout policies (G28) | Increased sovereign credit risk (F34) |
| Nonstandard monetary policy measures by the ECB (E52) | Lower credit risk for sovereigns (F34) |
| Nonstandard monetary policy measures by the ECB (E52) | Lower credit risk for banks (G21) |
| Nonstandard monetary policy measures by the ECB (E52) | Increased bank risk (G21) |
| Sovereign risk shocks (F65) | Bank risk (G21) |
| Bank risk shocks (G21) | Sovereign risk (F34) |
| Sovereign risk in euro area periphery (F34) | Core countries (O57) |